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Car sales skyrocket amid fears of high consumer debts and a slowing economy

How new models and subprime loans sparked a buying frenzy

Were it in a smaller community, Edmonton’s Crosstown Auto Centre could easily be mistaken for the local mall. The gleaming 80,000 sq.-foot Chrysler dealership is fronted by an expansive exterior parking lot and a coliseum-like entrance to its airy showroom. Inside, there’s a customer lounge with a fireplace and café, a children’s playroom and a parts store. The service bays include an express lane that promises oil changes in 30 minutes, no appointment necessary. All of those amenities have been put to good use in recent months. “In Alberta, we’re into the truck business,” says Joe Medina, who runs the dealership. “And with all the stuff going on around Edmonton, with all the refineries and projects that are being built right now, it’s really fuelling sales. We’re blessed to be in this part of the country.”

It’s not just Crosstown where polished metal is flying off the lot. Showrooms across the country are packed. So far this year, new vehicle sales are up nearly nine per cent in Alberta, according to Dennis DesRosiers, a Canadian industry analyst. Manitoba has posted a similarly healthy gain of 10 per cent, while sales in Saskatchewan and B.C. are both up five per cent. Even Quebec and Ontario, hit hardest by the 2009 recession, are witnessing rebounding demand, with year-over-year sales climbing five per cent in both provinces for April. Meanwhile, south of the border, demand is ramping up so quickly that automakers are considering running assembly plants throughout the summer, a period when production generally slows. All of this while economists fret about stalled economic growth and stubbornly high unemployment in both countries.

The North American auto market isn’t just robust, it’s booming, with Canada on track to exceed the 1.7 million vehicle sales record set back in 2002 (after very nearly matching it last year). The resurgence is driven by several factors. Consumers who put off new vehicle purchases during the recession are now being forced to replace their aging rides—and they’re looking to do so at a time when attractive used vehicles are, for a host of reasons, difficult to come by. At the same time, car manufacturers came out of the downturn leaner and meaner, and are mostly delivering on their promise of building exciting new vehicles that people actually want to buy.

But the most important driver of auto sales these days is all the cheap money floating around. With interest rates at record lows, the cost of financing a car purchase has plummeted. And lenders have stretched out their loan terms to as high as 96 months, or eight years, to keep car customers’ monthly payments down. When advertised as biweekly installments of less than $100 (for a new Dodge Grand Caravan, for instance), car payments seem as affordable as taking the family out for dinner. That’s helped thousands of Canadians inhale that new car smell, but also threatens to add to the country’s alarmingly high levels of consumer debt, a trend that could come back to bite the industry.

The sheer number of new models that began hitting showrooms last year is the most outward sign of an industry firmly back on its feet. Whereas a typical year sees an average of 45 new model introductions, the 2013 model year had a record 70 new or updated models unveiled at car shows, according to DesRosiers. They range from efforts like the new Dodge Dart to redesigns for stalwarts like the Chevy Malibu and Honda Accord. And for Medina’s clientele of oil and construction workers, there’s the 2013 Dodge Ram 1500.

Dealers are also getting a boost from manufacturer-subsidized incentives, like cash-back offers, which were supposed to have died along with Detroit’s penchant for building giant, gas-guzzling trucks and SUVs. That went out the window after Japanese giant Toyota began offering incentives in the wake of big vehicle recalls and supply-chain issues stemming from Japan’s tsunami. “In my career I’ve never seen incentives so high on new vehicles,” says DesRosiers. In Alberta, the “dealer allowance” on a new half-tonne truck is as much as $9,250, according to Medina. “So even making the transition from a 2011 model to a 2012 is really not that much money,” he says.

There’s no shortage of potential buyers, either. A recent report by Dina Ignjatovic, an economist at Toronto-Dominion Bank, said just over half of all vehicles on Canadian roads are eight years of age or older, and that, on average, Canadians drive their vehicles for eight to nine years. “As such, replacement demand will be a key driver of auto sales going forward, accounting for roughly two-thirds of total sales,” Ignjatovic wrote.

Pat Priestner, the CEO of AutoCanada, the publicly traded company that owns Crosstown and 29 other franchised dealerships across the country, says he too sees sales remaining at robust levels for the foreseeable future. He adds that the purchase cycle is shrinking for many customers thanks to the industry’s focus on high-tech bells and whistles—everything from cabin-noise-cancellation systems to rear gates that can be opened with a wave of the foot (if your arms are full of groceries). “People like the latest Apple products and TVs,” Priestner says. “It’s no different with automobiles.”

A scarcity of used cars is also helping to deliver consumers to dealer’s showrooms. Though websites like AutoTrader are full of advertisements, finding a good deal on a car that’s just a few years old has become a recipe for frustration. The phenomenon is a direct result of the 2008 financial crisis. Rental companies stopped buying new fleet vehicles and the leasing industry all but collapsed when automakers could no longer find lenders willing to finance the cars. Both are key sources for lightly used, late-model-year used vehicles. The number of formerly leased or fleet vehicles expected to come on the market this year will total just 445,000, according to DesRosiers, compared to a high of 954,000 vehicles in 2009. That, in turn, has caused the average price of a four-year-old passenger car to spike over the last few years to as much as 48 per cent of the manufacturers’ recommended selling price, or MSRP, compared to about 35 per cent previously.

With prices high and showrooms packed, the financing business is booming. “The credit lines have really opened up,” Medina says. “There’s way more accessibility for people, including in the subprime business.” Earlier this month, South Carolina-based Valley Auto Loans, which bills itself as “the leading auto and cars finance provider,” announced plans to expand its U.S. “bad credit” auto loans business to Canada. Brian Murphy, the senior manager of J.D. Power and Associates’ automotive practice in Canada, says car-loan companies have effectively replicated the low monthly payments previously associated with vehicle leases by offering longer terms. The average term of a car loan in Canada is now 71 months, compared to 61 months in 2008. More attractive financing deals have helped dealers, too. Canada’s big banks are in the midst of a push to grab a bigger slice of the dealership financing business after TD bought Chrysler Financial in 2011 and Royal Bank of Canada struck a deal to buy Ally Financial, GM’s former auto-lending arm last year.

The downside of those long financing periods are that car buyers increasingly risk being “upside down” on their car loans, meaning they owe more on their cars than they’re actually worth. That generally occurs at about the five-year mark for most vehicles. By J.D. Power’s calculations, as many as a third of all car buyers who intend to trade in vehicles still owe money on them, compared to about 20 per cent five years ago. “They’re using low monthly payments to attract these customers” says Lubo Li, a senior director at J.D. Power, adding that the trend has essentially shifted the risk from auto lenders, as was the case with leasing, to already indebted consumers. “But I don’t think consumers have a very good sense of what it means to have 86-month financing. It’s a risk not only to consumers, but to the financial system.”

The industry doesn’t seem overly worried. Priestner argues that “negative equity” on vehicles is nothing new, and that manufacturers’ incentives have helped offset the differences. Plus, automakers have long counted on the fact that people, regardless of how dire their personal finances, are more likely to stop making payments for their houses before their cars, which they rely on to get to work or, in the case of the unemployed, job interviews. “I’ve been doing this for 40 years,” Priestner says. “The delinquency rate on auto loans is extremely low. I don’t think that’s going to change too much.” Automakers like to boast that their vehicles sell themselves. But in 2013, there’s far more going on under the hood.

Here’s the per cent change in car buying from April 2012 to April 2013, by province:

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